If you sell your inheritance, capital gains tax is a possibility. It doesn't matter whether the "capital asset" you inherited is a house, stocks or jewelry. When you sell property you bought, your capital gains are roughly the difference between the purchase and sale prices. With capital gains tax on inherited real estate or stocks, the rules are different.
Inherited Property Stepped Up Value
Suppose you inherit a house from your mother that she bought 40 years ago for $100,000: it's prime real estate and now worth $250,000. If your mother had sold it right before she died, she'd have paid tax on $150,000 of capital gains to the Internal Revenue Service.
When you inherit, however, that gain is wiped out. Your basis, which is the amount you subtract from your eventual sale price to measure the gain, is $250,000. If you sell the house for that amount, there's no capital gains and no tax. This is called a step up in basis in IRS terminology.
Capital gains rates are already paid at a lower rate than ordinary income tax. Most taxpayers pay a rate of 15 percent, while some pay 20 percent or 0 percent. Capital gains on assets held for less than a year are taxed at ordinary income rates.
If the deceased had to pay estate tax or state inheritance tax, his executor will have to figure out and report the value of all the deceased's property. You can use those figures as the cost basis of your inheritance. Most estates do not pay estate tax unless their assets are quite large.
If the estate wasn't subject to tax, a professional appraisal will do the trick for you. The exception is if you or your spouse gave the property to the deceased in the year before he died. In that case, your basis is its value when you gave it to the deceased.
Include Form 8949 with your Form 1040 to report the sale of your inherited property. You report the amount of your capital gains to the IRS on Schedule D. Capital gains tax is normally equal to your regular income-tax rate if you sell an asset within a year of buying it. No matter when you sell an inheritance, however, you treat it as if you held it for more than a year, which gives you a lower rate.
Handling Capital Losses
The flip side of not paying tax on the deceased's gain is that you can't deduct anything for any of the deceased's losses. If your father's stock portfolio dropped from $100,000 to $60,000 right before his death, your basis when you inherit is only $60,000. If your father had sold the stock, he could have written off a $40,000 capital loss on his taxes, but you can't.
If the price drops after you inherit, however, and you sell for less than your basis, you can claim a capital loss. You can deduct capital losses from capital gains or deduct up to $3,000 per year in capital losses from ordinary income. Roll over unused capital loss deductions into later years until they're exhausted.
2018 Tax Law Changes
Long term capital gains rates and rules are staying roughly the same for 2018. Ordinary income rates, on the other hand, are generally declining, which could mean less tax owed on short term gains compared to previous years.
The cutoff for estates being taxed is $11,180,000 per person in 2018, meaning only very valuable estates will be taxed.
2017 Tax Law Situation
Use the 2017 tax rates for 2017 tax returns, even if you're filing in 2018 or a later year.
The cutoff for estates being subject to federal estate tax was $5.49 million in 2017.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.